Monday, March 21, 2011

Why do firms fire workers instead of reducing their pay?

Because workers respond to wage cuts by shirking:
So it seems bosses are smart not to cut wages. It's bad for morale, which is bad for productivity. Sending out pink slips might seem similarly demoralizing, and thus bad for productivity, but layoffs have a more complicated effect on the lucky employees who hang on to their jobs. Layoffs can even boost productivity by giving workers a bit of extra motivation to prove their value, ...

BOTTOM LINE: Raises Don't Make Employees Work Harder, But pay cuts make them slack off.


  1. Also, so long as there aren't odd union rules about layoffs, you can lay off the workers with the lowest marginal net productivity, which will statistically improve the average net productivity even if it doesn't change worker behavior whatsoever.

    Furthermore, a significant percentage of a worker's compensation is in fixed costs (benefits etc) and are difficult (sometimes illegal) to cut without firing the worker. This is why I say if you want to lower unemployment, you should remove laws that mandate fixed costs to employing workers.

  2. Reducing pay for workers would cause employee morale to be very low. If workers are already not doing their job well, reducing their pay would just incentivize the workers to continue to not do a good job. On the other hand, there is probably a few percent of the population that this tactic would work on. It could do the exact opposite and incentivize employees to give their best. Layoffs could also work like this. When employees see someone get laid off they could be driven to perform their best in order to prevent losing their job. However, employees can respond to wage cuts by shirking. Shirking is when employees do less work when they know that they aren’t be rewarded properly. This is a type of a moral hazard. This is one reason why employers would rather just fire workers than cut their pay. Employers know that if they give wage cuts, a majority of their employees will respond by doing as little work as possible. It’s better in the employer’s point of view that they just fire the workers who don’t contribute as much and hire new workers’ who genuinely want to do a good job and who work hard. Shirking also happens when employees don’t think they are being monitored. Some employees will not work as hard if they don’t think they their employers are measuring their performance.